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HMRC internal manual

Partnership Manual

Limited partnerships and limited liability partnerships: venture capital/private equity and the BVCA agreement

Limited Partnerships have become more common since 1987, when the British Venture Capital Association (BVCA) published guidelines on how they might be used as investment funds. In 2003, the BVCA and the Inland Revenue (as it was then) entered into a Memorandum of Understanding regarding the tax treatment of such LPs and associated arrangements. Full details are contained within the memorandum and this section seeks only to summarise how such arrangements will operate in practice. Guidance on relevant parts of the BVCA guidelines is at CTM36580.

As mentioned, an investment fund will often be structured as a Limited Partnership. This will be managed by a fund management business, typically structured as a Limited Liability Partnership or a company. The fund management business will receive a management fee from the fund, usually at a rate of one to two per cent of the fund’s assets under management per annum.

However, certain individuals (partners, directors or employees of the management business) will also be rewarded through “carried interest” arrangements. Carried interest arrangements provide a mechanism to incentivise the individuals involved in the management of an investment fund. These individuals will form a separate, special purpose carried interest Limited Partnership which will itself be a member of the fund. To achieve this, the carried interest Limited Partnership will need to be one that has its own legal personality, such as a Scottish Limited Partnership.

Other members of the fund partnership will be the investors. If the fund is successful, typically about 20% of the fund’s profits will be allocated to the carried interest partnership. Under the BVCA/HMRC Memorandum of Understanding, if certain conditions are met, such profits will be taxed as capital gains on the limited partners of the special purpose Limited Partnership, i.e. the individuals involved in managing the fund.

The allocation of the carried interest to the carried interest holder is a transfer of fractional interests in the fund partnership for CG purposes. As such, the no gain/no loss treatment described in Paragraph 4 of SP D12 will apply (see PM60200 for further on SP D12). This means that the CG base cost of the carried interest holder’s interest will be increased by the amount subscribed by the other members, i.e. the fund investors; this is known as “base cost shift”. The CG base cost of the investor members’ fund partnership interests will be reduced accordingly but the investors will often be outside the scope of UK capital gains tax.